Credit Squeeze Forges Some Atypical Unions

Just because it's difficult to borrow money doesn't mean development plans need to come to a halt. In fact, the credit crunch--and the resultant drop in available construction financing--has given rise to some new partnerships. Retail REITs, with mountains of cash at the ready, are increasingly joining forces with small local and regional developers to enable projects that otherwise might not move forward.

For example, two weeks ago, Santa Monica, Calif.-based Macerich Co. announced a joint venture agreement with DMB Associates, Inc., a Scottsdale, Ariz.-based diversified real estate investment and development company, to build One Scottsdale, a 120-acre mixed-use project in Scottsdale. Macerich will head up the retail component of the project, while DMB will oversee the residential, office and hospitality portions.

In another example, Chattanooga, Tenn.-based CBL & Associates Properties, Inc. broke ground on two large-scale shopping centers in Florida--Pavilion at Port Orange in Port Orange boasting 550,000 square feet and the 750,000-square-foot Hammock Landing in West Melbourne. Both open-air centers result from a partnership with the Benchmark Group, an Amherst, N.Y.-based privately held real estate developer.

REITs have been forming joint ventures for decades. What makes this recent round notable is how the ventures differ from previous marriages. In recent years, REITs primarily have joined with institutional investors, such as pension funds, largely for the purpose of making big acquisitions. The rationale driving such unions was that cap rates were too low for REITs to buy alone while meeting the stringent return requirements allowing them to pay dividends to shareholders. Instead, the institutions--which could afford the lower cap rates--provided the bulk of the equity with REITs collecting leasing, management and other fees to hit their targeted return levels. Recent joint ventures in this mode included Ramco-Gershenson Properties Trust's partnership with ING Clarion and Inland Western Retail Real Estate Trust, Inc.'s venture with a pension fund advised by Morgan Stanley Real Estate, focused on acquisitions.

The latest round of joint ventures is different. The unions are developing projects, not acquiring them. And the partnerships are coming at a time when many firms are scaling back projects, delaying construction or scrapping plans to build altogether. Developers are seeing retailers close stores and scale back on expansions. Others are having difficulties lining up the necessary financing to build.

These ventures signal that there are still areas across the country that can sustain new construction. Moreover, they solve the financing conundrum by teaming developers that have assembled sites, but have no funding, with REITs that have deep pockets and see an opportunity to grow portfolios without shouldering all the development risk. The joint ventures also minimize the risk for both parties, which is helpful given that projected development yields have dropped from the high double-digits to the mid single-digits in recent months.

On mixed-use projects such as One Scottsdale, a developer, such as Macerich, can focus on the retail component while its partner takes on the more challenging residential piece, notes Rich Moore, an analyst with RBC Capital Markets. "They are adding a high-end housing component because it's right for the asset, but they don't have the responsibility to develop it themselves."

"We have the ability to get them on the phone and get a quick honest answer," says Geoff Smith, vice president of development with CBL. "We also have a relatively large and experienced leasing staff and can put a great deal of human resources into the project, smaller developers would have to outsource."

As a result, there could be more joint venture development deals in the short term. According to Smith, CBL is already scouting several sites with the Benchmark Group and Moore has heard that Ramco-Gershenson is close to announcing its own joint venture project.

"There have always been these types of ventures where a small guy with land finds someone to help him build," says Moore. "But given that capital is hard to come by, it's certainly a good environment to do it."

"It's tough for companies to be all things to all stakeholders. This joint venture is an approach where we will be leveraging DMB's place-making ability and complementing it with our experience of bringing world-class retail to the project. I think it's a model that has a lot of traction," says Scott Nelson, vice president of development with Macerich.